With a new factory half-built, Koito -- a Toyota Motor
Corp. supplier -- reasoned that it may no longer need it.

“Demand from automakers is unclear, so we don’t know how
long we will have to freeze the project,” said Shinji Karasawa,
spokesman for the Tokyo-based headlight maker.

Along with Koito, Japanese parts-makers including Sumitomo
Electric Industries Ltd. and Toyo Tire & Rubber Co. are
rethinking plans to expand in China, where Toyota’s sales
plunged 41 percent in September as demonstrations over disputed
East China Sea islands flared. The manufacturers are focusing
expansion plans on Thailand, Vietnam, Myanmar, Indonesia and
Cambodia, a sign that this year’s drop in Japanese investment in
China may deepen next year, crimping bilateral trade that has
tripled to $340 billion in the last decade.

“Our board members had been vaguely wondering if we should
move future production out of China; then the protests prodded
us to decide to accelerate planning toward moving out,” said
Masayoshi Matsumoto, president of Sumitomo Electric, the world’s
second-biggest maker of wiring harnesses.

Sumitomo Electric fell 1.6 percent to 817 yen at the close
of trading on the Tokyo Stock Exchange today, while Koito fell
1.9 percent to 998 yen. The benchmark Nikkei 225 Stock Average
dropped 0.9 percent.

Foreign direct investment in China fell 6.8 percent in
September, the 10th decline in 11 months, according to data
compiled by Bloomberg.

Investment Slump

By contrast, direct investment by Japanese in China last
year surged 74 percent to $12.6 billion, from $7.3 billion in
2010 and $2.6 billion 10 years earlier, making Japan the biggest
investor in China after Hong Kong and Taiwan, according to the
Japan External Trade Organization.

Protests in China over Japan’s claims to a group of
uninhabited islands in the East China sea have slashed sales at
Toyota, Nissan Motor Co. and Honda Motor Co. in the world’s
second-biggest economy, where some drivers are boycotting goods
made by Japanese companies and others are concerned about
potential vandalism such a purchase may invite.

Nissan, the biggest Japanese automaker in China by sales,
on Nov. 6 cut its sales forecast for China and said the
reduction would wipe about 60 billion yen off annual operating
income.

Being ‘Careful’

“We will be careful about investing in China in the
future,” Nissan Chief Operating Officer Toshiyuki Shiga told
reporters in Tokyo.

The parts-makers supplying Nissan, Honda and Toyota in
China, Japan’s largest trading partner, may be even more
vulnerable than their customers to declines in auto sales
because their businesses are smaller and less globalized.

Mamoru Shimada, president of Osaka-based precision auto-parts-maker Fuserashi Co., canceled a visit to China originally
scheduled for this month after anti-Japanese demonstrations.
Instead, he visited Malaysia and Indonesia, seeking
opportunities to expand production into those countries.

“We planned to increase capacity in our China business,”
Shimada said in an interview. “But with the risks shown by the
protests, I’m inclined to expand future production in Thailand,
where we already have a factory.”

Territory Disputes

Shimada said he regularly meets with Japanese carmakers to
discuss global and regional expansion plans. In October, plans
for China didn’t come up during the meetings, he said.

“That made me feel pessimistic about the future for our
business in China,” he said.

China-Japan disputes have periodically surfaced in the
decades since World War II over territorial claims and the
acknowledgment of responsibility for massacres during Japan’s
invasion and partial occupation of the country. At the same
time, industrial alliances between the two countries have
thrived as Japanese manufacturers sought the country’s lower
costs and Chinese companies welcomed Japanese technology and
know-how.

The latest cycle of increased tension is prompting some
executives to talk about exiting China as a matter of national
pride as well as a business decision.

Territory ‘Invaded’

Shimada of Fuserashi likened China’s actions amid the
island dispute to an invasion, citing it as a reason to exit the
country and focus on emerging markets elsewhere.

“There’s no need to do business at the price of your own
territory is being invaded,” he said. “It’s better if we can
concentrate in other emerging markets, like Brazil, to make up
for the Chinese market.”

China’s failure to prevent anti-Japanese violence came as a
surprise and has made the country too risky, said Matsumoto of
Sumitomo Electric.

“None of us had expected what happened in September,” he
said. “All of our board members now agree on the idea that we
should move production out of China to other countries after we
saw such big risks.”

Leaving China altogether hasn’t been mentioned as an option
by any of Japan’s largest automakers, a sign that it’s unlikely
their suppliers would relocate all production to other
countries. More likely, the suppliers will reconsider plans to
make parts in China for export.

“China remains an important market from which we can’t
retreat, but when it comes to increasing investment, we may be
more inclined to do it in other countries, such as Malaysia,”
Kenji Nakakura, 64, Toyo Tire president, said in a September
interview.

The Osaka-based company resumed production Sept. 19 at its
factory in Qingdao, China, after suspending it for a day amid
anti-Japanese protests.

China’s Importance

“Japanese carmakers don’t have much of an option, because
the Chinese market is too important,” Lin Huaibin, an
automotive analyst at Global Insight Inc., said by phone.
“Carmakers have never said they are going to leave China, and
if they stay, the parts-makers will have to stay, too.”

Chinese and Japanese officials last week ended two days of
talks. China reiterated that it “won’t cede even half a step on
its sovereignty” over the chain of islets, Foreign Ministry
spokesman Hong Lei said Nov. 5 in Beijing.

“To be honest, there is a gap between us,” Japanese
Foreign Minister Koichiro Gemba told reporters Nov. 6 in Tokyo.
“I feel this is going to take some time.”

The dispute potentially could grow into a military face-off, according to a confidential report submitted last week to
Secretary of State Hillary Clinton by a delegation of former
U.S. officials.

Both Japan’s parts-makers and China’s economy would lose
from such a clash, said Shoichi Ito, a Kwansei Gakuin University
economics professor.

“If China causes these industries to move out, it will be
the equivalent strangling their own necks in the long term, as
China is undergoing the transition from labor intensive to high
value-added industries,” said Ito, author of “Labor Markets in
Modern China.” “The impact will be traumatic.”